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Month: September 2016

Man this reflationary trade is getting long in the tooth. The dollar has been subdued for 9 months now and all the bears have either gone back in their caves or transmogrified into bulls. OPEC’s production cut is icing on the proverbial cake at this point.

As a result investors have turned dare I say “wildly” bullish on emerging markets. The demographics look great. The yield is phenomenal. If the dollar stays where it is or goes lower it will rip higher! But what if the dollar doesn’t do any of those things. What if, EM forbid, it begins to rise?

Investors have convinced themselves that the stresses on the global economy that brought about the January sell off have dissipated. When in reality, they’ve actually grown tremendously.

“Right now, the markets are lulled to sleep… People become used to the stable China narrative until they start looking more closely into the data.”

But he goes even further.

“I’d find it earth-shatteringly surprising if we don’t have a significant problem between now and China’s leadership change… This is not a stable economy. It’s one that twists and turns and happens to end up at the same spot. There are real problems below the surface.”

“prices keep rising in major Chinese metropolises like Shanghai but are falling in thousands of smaller cities where huge numbers of properties lie empty.”

In essence, money is crowding into the good and leaving the bad investments. Starving the weak to feed the strong will only exacerbate the current issues facing China. The situation is so bad that Wang Jianlin doesn’t even see a palatable solution.

“I don’t see a good solution to this problem… The government has come up with all sorts of measures — limiting purchase or credit — but none have worked.”

The situation is so bad that the very restrictions meant to curb speculation have actually driven demand higher.

I think the situation has become so bad that the CCP and the PBOC may have realistically just one option left, and that is to drain liquidity from the entire economy. It will hurt. It will hurt A LOT but at this point it’s more valuable to deflate the bubbles before they get systemic and potentially destabilizing (although an argument could be made we past that point long ago). And that is for now, exactly what the PBOC is doing:

“China’s benchmark money-market rate climbed to a 14-month high as the central bank pulled funds from the financial system and commercial lenders stocked up on cash to meet quarter-end requirements.

The seven-day repurchase rate, the benchmark gauge of funding availability in the financial system, rose 12 basis points to 2.75 percent as of 5:07 p.m. in Shanghai. That’s the most expensive since July last year.”

China’s desire to deflate its asset bubbles requires that the Yuan remain strong. Although I’d argue, the PBOC isn’t actually picking a currency level so much as the limit to the size of its asset bubbles which results in a stronger Yuan. In the end, the result is the same. China is finally trying to deflate its financial bubbles with the most blunt tool in its arsenal, liquidity. As Jeffery Snider notes:

“The problem of picking CNY rather than SHIBOR is this money market “uncertainty principle” where if you hold steady the currency (thus “dollars”) you have to let internal liquidity deteriorate. The test came on August 30 when the overnight rate in SHIBOR moved above 2.06% and the PBOC let it by holding fast to CNY. It has only paused in its ascent for one day since then, fixing at 2.095% today.”

Make no mistake, this is an incredibly dangerous game to play. Chinese banks are increasingly relying on not only short term funding but each other for those very funds. Rising short term rates will only exacerbate these issues.

This liquidity issue is not endemic to China. In case that wasn’t evident based on rising LIBOR, negative Yen/dollar and Euro/dollar basis swaps, Deutsche Bank stock hitting fresh lows and Saudi Arabian Banking stocks trading below the February lows. There is a global dollar liquidity problem. Ignore the connections at your own peril. Suffice it to say, it’s not all that surprising the global trade has ground to a halt.

“The World Trade Organization cut its forecast for global trade growth this year by more than a third on Tuesday, reflecting a slowdown in China and falling levels of imports into the United States.”

Falling levels of imports into the US translates into less dollars abroad further exacerbating the very liquidity problems that are grinding global trade to a halt. To say I’m bearish right now would be an understatement. With consensus turning bullish on EM and bearish the dollar, I could not think of a better opportunity to short some risk assets.

Given the liquidity stress, the demand for good collateral such as US treasuries is likely to rise and exceed any selling pressure unleashed by risk parity funds. Although right now that is pure speculation and I will be watching for signs to tell me otherwise. With that said I am holding a small bond position and will not look to add till I better understand the dynamics going forward.

Against the backdrop of potentially falling rates, a rising dollar and rising liquidity risk it isn’t abundantly clear what gold will do. Overall, this is the beginning of an investment theme I expect to take hold over the next three months. More research and time must be devoted before trades and “predictions” can be made. Would you like to know more?

The story of the Japanese Yen will go down in the annals of central planning history. Imagine if the US housing authorities noticed there was a housing bubble forming in 1990 and they absolutely did everything they could to stop people from buying houses, but in spite of their best efforts the bubble grew and grew for over 25 years.

I know. I know. It sounds absolutely ridiculous that the US wouldn’t have the capacity to prevent a bubble in US real estate even if it knew and actively worked to solve the problem, and yet that’s EXACTLY what I’m ask you to picture – an institution powerless to stop a massive financial bubble.

There is a massive bubble in the Japanese Yen and only the BOJ seems to know it. Not only does the BOJ know it, but it has been actively warning people to sell it, and yet people keep buying. Much to the central bank’s chagrin, the damn thing keeps rising.

So the BOJ prints some currency, showing just how easy it is to obtain and thereby proving its true worth. But that’s not enough, the currency continues to appreciate. The BOJ is forced to up its game and starts purchasing bonds with the newly printed money. But when even that wasn’t enough, they bought equities, but the currency still rose.

Nothing works. It didn’t matter what the BOJ did with the currency, people wouldn’t stop buying it. Almost all hope was lost. But then something happened. A change in the winds, a turning of the tide at the most opportune time…

For the first time in over 25 years, a member of the BOJ uttered the Greek word synonymous with invention-

EUREKA!

The BOJ finally discovered where the Yen’s true value lied. Not in the physical paper, nor the imaginary numbers on the computer screen, no the true value rest at the heart of the BOJ.

Manipulating one point on the yield curve is nigh impossible, the members of the BOJ thought they would look insane if they tried to manipulate more points on the curve. And that is exactly what they did. “Yield curve control” was never meant to boost lending in the Japanese economy but destroy faith in the institution that controls the yen.

"This is our world in 2016: A central bank needs credibility so it can damage its credibility." https://t.co/3Bkai86kBq

OK. I’m only mildly joking. I don’t actually believe the BOJ specifically instituted “yield curve control” to purposefully destroy their credibility… although that may be exactly what it looks like, it is not. They have hearts of gold over there at the BOJ.

In all seriousness I’m trying to give a very important point here. The Yen is in a bubble, and not only can it go much higher from here but the only thing capable of bringing this beast down is investor psychology. How to determine the psychological breaking points are almost impossible ahead of time. Instead we must rely on charts and sentiment.

CNYJPY bouncing off its 38.2% retracement level off the 2012-2015 move. Notice the breaking of the downward trend-line in RSI.

Note the possible break above 12 month trend line resistance with a positive. With momentum POSSIBLY diverging at the same time.

Unsurprisingly USDJPY behaves quite similarly, but the dollar I believe is on a pause heading higher. Stiff resistance at the 50% fib retracement level from the 2012-2015 move. Once again, note a potential break in RSI trend. Potentially just on a break before it rips lower, but it remains to be seen.

Finally short term momentum has turned positive while the USDJPY flattened. Make no mistake, the Yen is near a major tipping point. Which ever way it goes from here will most likely be as surprising at it is violent.

Lastly I turn the attention to XAUJPY, because in the end, gold is the master of all fiat currencies. On the 1 month graph, over the last few years XAUJPY has been rangebound since 2011. Most interesting is the upper range is bounded by the 161% extension of the 2000-2008 rally. Right now it’s in no danger of being broken for a 3rd time. However, another long term trend line from the early 2000’s now appears to be acting as support. Lastly, momentum in this cross also appears to be waning. It will be interesting to see which way this breaks.

Overall, the Yen’s upward momentum appears to have slowed considerably. Key technical levels have been tested this year multiple times. It will be a fun one to watch.

“See, madness, as you know, is like gravity: all it takes is a little push.” ~ Heath Ledger’s Joker

Following up with yesterday’s post, the BOJ prayers for eagles were answered with doves. Once again the Fed decided to keep the rate hike on hold and left the BOJ hanging. The irrational nature of faith in central banks makes it incredibly difficult to predict when it will reach a tipping point. The only thing one can do is notice which way the needle moves.

@georgemagnus1 it's the old-fashioned kitchen sink approach. The signal (markets should take away) is desperation

Yellen’s press conference had noticeably tougher questions this time around, fielding questions about Trump and central banking credibility. And of course, the BOJ with its “yield curve control” program is certainly not helping to alleviate those concerns of central bank incompetence.

The market has not yet fully considered/understood the actions necessary for the BOJ to implement its “yield curve control” policy. The BOJ was purposefully unclear on how exactly it would raise long term interest rates while monetizing the entire bond market. Even Goldman Sachs hasn’t a clue how this will be accomplished

Recall back in 1930’s when FDR first stole all the gold in the US, and then promptly raised the price once they had all the gold. For all intents and purposes, the BOJ is the JGB market, and unlike gold they control an imaginary faith based asset that is more easily manipulated. It’s a scary thing to admit but the BOJ can do whatever it wants as long as the market is OK with it.

However, this manipulation is not without its price. The JGB market has not functioned properly for years, and this recent move is the icing on the cake. The potential spill over effects to the repo markets and thereby the Japanese banking sector are enormous.

I’m not a financial plumbing guy, but the optics of this situation look abhorrent to say the least, I highly recommend you take a look a Jeffery Snider’s work on the subject. I’m not sure what’s more troubling, the fact that Libor is at its highest point since the crisis or that this steep rise has followed an unprecedented period of calm.

Perhaps more even more worrying is Deutsche Bank’s behavior. The following is an excerpt from an article titled “Is Deutsche Bank Cooking its Derivatives Book to Hide Huge Losses?” written by Mike Shedlock:

“I do not know if the problem is derivatives, the eurozone mess, negative interest rates, counter-party risk, or some combination of the above, but the above images collectively say something is seriously wrong, not only with Deutsche Bank, but the European banking system in general.”

The point is, central banks can shift or hide risk, but they can’t erase it entirely. These aren’t Hillary Clinton’s emails, and the market will hold them accountable one way or another. In the case of Japan, my eyes are on the Yen. With these dangerous new steps, the BOJ is increasingly pushing itself further out on a limb.

Remember, the BOJ chose not to accelerate the growth in its balance sheet which is the most effective tool for moving exchange rates. In the end, the BOJ’s many actions did very little to alleviate any upward pressure on the Yen. It will be interesting to see if the Yen continues to appreciate from here.

Depending on where the US economy is in its cycle, a further slowdown from here could push the dollar weaker and the Yen even higher. If US growth slows further weakening the dollar, the globe could find itself in a bit of a dollar funding squeeze as exports to the US fall.This dollar funding squeeze would most likely set the stage for a massive dollar rally.

Looking at the chart, the dollar could break either way, and given a foreign shock the dollar along with the Yen would likely go much higher, but where the dollar actually wants to go, where it’s headed, may actually be lower.

If you think about that magnificent 2014 run the dollar was on, a large part of the momentum may have been driven by a tightening Fed and an accelerating US economy. Recall market expectations were that the US economy would grow at over 3% a year and the Fed Funds rate would rise to 2%.

Instead we have sub 2% growth and the Fed funds rate is pinned to the floor. So it’s not surprising that given all the financial stress in the global economy that the dollar is not rising. The dollar over shot its target based on ridiculous expectations and now we may be witnessing a counter swing move that too goes further than it “logically” should.

If you recall, the false breakdown in DXY in May of this year was barely saved by a few hawkish speeches by FOMC members, you start to wonder if the threat of future rate hikes is the only thing keeping the dollar elevated at this point.

If the US economy continues to slow, the data may no longer support another Fed rate hike. The Fed would then be forced to capitulate and without threat of a further rate hike the dollar will finally bottom and mark a tremendous buying opportunity. Sounds fancy and maybe it just might happen.

From a currency perspective, the BOJ is like a workaholic Dad that can never make it to his son’s soccer games.

The BOJ has been missed little Takagi’s soccer games for over 9 months now.

Today, the BOJ’s response was incredibly weak, choosing to talk up its current policy rather than expand its actions. At least they finally acknowledged that their inflation target was ridiculous. Somehow we are led to believe that this admission will have a positive impact on long term Japanese bond yields.

But by not expanding its current programs, the BOJ is subtly copping to market fears that the BOJ also is worried about the limits of its tools. I don’t think I really need to show the BOJ’s balance sheet again, but why not, the image is just so effective.

Instead of cutting rates, or buying more bonds, the BOJ will “fluctuate” its purchases of JGBs. Keep in mind that the BOJ buys 16% of GDP worth of JGBs while the government runs a deficit less than half of that.

When the BOJ buys more bonds than are issued, rates fall, not rise. And yet, the BOJ is determined to engineer higher long term rates through “fluctuations” in its purchases. I ask how?

Unless the Japanese word for fluctuation actually means taper, I struggle to see how the BOJ will force long term rates “higher” while soaking up an extra 10% of GDP worth of JGBs a year. And if the BOJ starts to Taper its bond buying program, then what happens to the Yen? Do they really believe that cutting asset purchases will actually weaken the Yen?

After everything the central banks have told markets, is the BOJ really going to communicate that they believe QE no longer weakens currencies?

Although Japanese banking health seemed to be the priority of THIS policy move, the main goal of the BOJ has been to weaken the Yen at all costs.

For the longest time, the BOJ’s primary concern has been the Yen. Today’s policy action seems to mark a shift if albeit temporarily in the BOJ’s priorities as they appear to be incredibly concerned with the stability of the Japanese banking sector.

The Yen has already rallied over 1% against the dollar since the announcement, we’ll see how long they stand-fast. Perhaps, like the characters in Lord Of The Rings, the BOJ has their own avian creature riding to the rescue, a sort of Deus Ex Machina to save them from their predicament.

It’s taken a while, but let’s cut them some slack, they’re only PhD economists. If I lobotomized the portion of my brain responsible for independent and logical thinking I don’t know if I could ever understand negative rates.

But here we are. The BOJ is clearly panicking. Negative interest rates were an obvious mistake, but I want to stress how the BOJ views the mistake versus what the actual mistake is.

When the BOJ introduced negative rates, the currency appreciated rapidly AND the yield curve crashed through the floor. In essence, the BOJ managed to inadvertently add a tax to its banking sector WHILE reducing any chance at profits. If that’s not a policy error I don’t know what is.

So now, the BOJ is trying to undo the damage its done to its banking system. And yet, it still needs to weaken the currency. Fortunately for Central Bank watchers such as myself, there aren’t many ways this can be done.

If we focus on the banks themselves, the BOJ can hand the banks money in the form of negative interest rate loans like the ECB’s TLTRO program. That would alleviate any of the negative interest rate tax. Because this would also slightly weaken the currency, I think this is highly likely.

Even if the BOJ gives the banks some money to paper over the losses due to negative interest rates, they still won’t have incentive to lend money with a flat yield curve and long term rates at sub 50bps for 30 years.

If banks don’t lend than the economy cannot grow, so it has been speculated the BOJ will try and manipulate the yield curve.

At a certain point you wonder why the BOJ bothers with appearances at all and doesn’t just fix the yield curve to whatever rates it “feels” appropriate.

For now, it looks like the BOJ is getting what it wants. Long term rates are steadily rising, although probably not enough to make a significant dent in Japanese bank lending.

That’s all well and great, but the BOJ is still monetizing more bonds than the Government of Japan can spit out. Outside of a massive “VaR shock” it’s unlikely that the BOJ can sustain its bond buying program and push long term rates up. Which means that if the BOJ doesn’t make good on its threat, this whole global bond sell off and everything that comes with it could reverse.

Which begs the question, how will the BOJ push rates higher? They’ve told the world that they want higher long term rates, but they haven’t told them how. It’s sort of like Trump and The Wall, we all know it won’t happen but go along with it anyways.

Unfortunately for the BOJ, they actually have to come up with a definitive plan of action in less than a week.

Strangely enough, there’s been actual talk of this plan including the BOJ tapering its JGB buying program. The idea being that if the BOJ stopped buying long term bonds, then new government issued supply would push yields up.

Without additional easing, that would be tantamount of tapering its QE. And that’s not going to happen, because if the BOJ has to keep expanding its balance sheet.

Just look at that chart. Incredible. At a certain point you think enough folks would lose faith in the Yen as a currency, but apparently we aren’t there… yet.

If the BOJ is going to purchase less long term bonds it will have to purchase something else in its place. This is where it gets tricky, because there just aren’t many deep liquid assets in Japan. The BOJ buys hundreds of billions of dollars worth of JGBs versus just billions of Equities. Sure the BOJ can buy some corporate credit, but once again, it won’t be enough to move the needle.

And here’s the kicker I think the BOJ knows this and will cut short term rates much deeper in a bid to weaken the Yen. The paradox being that a rate cut would further suppress long term yields and hurt banking profits.

So we may see a hybrid policy where the BOJ shifts a portion of purchases of long term JGBs by a few billion into an TLTRO program for the banks as well as corporate credit and top that off with another short term interest rate cut.

The “HOPE” (and I emphasize that word) that the combination of the moves will net out to a weaker Yen, higher long term rates, and profitable banks that have the incentive to lend.

I know what you’re thinking, why don’t they just balance a few plates on their head while their at it?

Now I’ve excluded the belief that the BOJ will turn its purchases assets to foreign liquid assets such as US treasuries or equities. I don’t think we are there yet. The BOJ has to completely tap out all domestic options before venturing abroad.

And you know what, so far, the BOJs talking has worked. The Yen hasn’t exactly been weakening, but that may be due to the fact that speculators haven’t been this bullish on the Yen since December 2011 which almost exactly timed the bottom in USDJPY.

It’s important to note that just 10 months later, Abe was elected and Abenomics was unleashed on the world. The Yen went on to lose 50% of its value over the next 3 years.

But given said speculation and the Yen’s refusal to go higher, it’s quite possible USDJPY is bottoming here at the 100 level which just so happens to be the 50% retracement of the 2012-2015 move. As demonstrated multiple times through out this post, I have my doubts, but it is best to remain open near such key inflection points.

The BOJ is playing with fire. After one policy error already this year, they appear to be on the verge to commit another. Cash remains the best asset class going forward.

And by extension the gold market which has also been a beneficiary of this irrational fear that rates will be low forever.

With bonds, stocks, gold, real estate all selling off at once, you start to worry about the sustainability of TINA. With bollinger bandwidth at a record low the SPY was down over 2%. The VIX has exploded 30% higher. TLT down over 1.5%. The serene calm of the summer market has officially ended.

What sparked this event? It was the Fed’s unwillingness to back down from its threat to hike rates in 2 weeks time. The market doesn’t like that. The market doesn’t like that at all. I don’t believe the market will tolerate the Fed hiking rates and it will happily let the Fed know that.

For me the question of where the market goes over the next few weeks depends on the speed at which the Fed can communicate to the market that it won’t hike rates this month.

Which reminds me of January. The Fed had infamously hiked the month prior and the market after a long quiet period from the holidays just opened in the red and never stopped. While the market was in free fall, the Fed continued to talk about the number of rate hikes they were going to do this year…

Lest we forget it’s September and they are still talking about hiking interest rates. Now why they are hiking interest rates may be completely unrelated to the actual health of the economy and have a lot more to do with the strength of the Japanese Yen, but that’s for another time.

The point is, the market is going to ask the Fed to not hike. Just how polite the market is in its request depends on how it takes for the Feds to capitulate. Apparently it won’t be too long.

That’s one down but we still need a few more magicians to cast some incantations if they want to stop this self induced stock market stupor. After all, the sheer amount of leverage on the long side of both bonds and stocks due to risk parity and short volatility etfs combined with deaf and blind bid for “low vol” stocks has turned into one of the biggest bubbles in a long time.

Apparently the US election is starting to show up in the US economic data. Businesses are pulling back in the uncertain environment. But that still doesn’t stop the Atlanta Fed from predicting US GDP growth in excess of 3%. I expect this number to come down by quite a bit. Remember at one point in time, the Atlanta Fed had predicted 2.8% GDP growth for Q2 2016 before revising it down to 1.1%.

Needless to say, the Fed won’t have trouble coming up with an excuse not to hike interest rates this month. The fact that August is normally a weak month for job growth as well, only increases the odds that the NFP number will be underwhelming, thereby allowing the Fed to back out of its recent calls to action.

I tend to agree with Mr. Harrison. I don’t think the Fed will seriously consider hiking unless the number is +300k. The market has different standards and will most likely interpret any number above 180k as a positive for a potential rate hike. But once again I must stress, in lieu of recent economic data, the odds of the number being in excess of 180k have fallen.

The recent move in dollar strength/yen weakness may be ending sooner than I originally thought. But that’s not all. US equity volatility is once again on the rise. After an incredibly quiet summer, traders are coming back to their desks and staring at a Fed that wants to hike, slowing economic data, and a very uncertain US election. Strap in, things are about to get interesting!